Political Shift in White House Unlikely to Clip Stock Market

The stock market loathes uncertainty. And with a presidential election year nearly upon us, there should be plenty of questions facing stocks as a crowded field of Republican candidates and two Democrats battle for the White House. For investors, history suggests it’s time to batten down the hatches and prepare for a rough ride.

The presidential election year cycle, which breaks down the historical performance of the Dow Jones Industrial Average by quarter over the four-year period of a presidential term, is heading into its seasonally worst 12-month period.[1] According to the Hulbert Financial Digest, the fourth quarter of a president’s third year in office and the first two quarters of the fourth year have historically produced gains of 1% or less while the third quarter of a term’s fourth year has produced an average loss of 1.5%. That roughly equates to a total return of about 1.5% for the year ended next September. But markets love certainty and once the dust settles next November 2 and a new president is elected, stocks tend to take off. The DJIA gains an average of nearly 5% in fourth quarter of year four and close to 4% in the first quarter of a new administration.

The promise of new policies and the optimism of new leadership should boost investor sentiment and be a boon for stocks, but research from CMC Markets2 finds that a political shift from one party to the other has been inconclusive in determining the future trajectory of stock market returns. In 11 instances of a party shift in the White House since 1900, the incoming President has seen improved stocks returns six times and reduced returns five times. In the five instances when a Republican took over from a Democrat, the incoming red stater did better than their predecessor three times.

Should the White House stay Democrat but lean more toward the left, certain sectors could be hurt. The selloff of biotech and pharmaceutical stocks in September shows the potential influence of a more liberal president. The sector suffered sharp declines following rhetoric from Hillary Clinton promising a plan to take on “price gouging” by drug makers. Her comments framed the debate between biotech and pharmaceutical makers, who believe market demand and the scarcity of breakthrough, life-saving treatments should determine pricing, and politicians campaigning for affordable access to such treatments. As Sanford Bernstein analyst Ronny Gal told CNBC, “The entire argument that the government will begin to behave [as controller of prescription prices] is something the drug industry has been fighting tooth and nail." Gal added that such a scenario could cut the stock prices of drug makers by 20%.[2]

Returning to the election cycle, historical comparisons of four-year market performance going back to 1900 tell us that a Democrat in the White House provides a tailwind to the stock market. But as the authors of “Bulls, Bears and the Ballot Box” explain, it is not so much about political party affiliations as how those politicians apply their policies to current conditions.[3] If the new president and Congress pass legislation to increase spending on transportation and energy infrastructure—both needed to jumpstart the industrials, energy, and materials sectors of the economy—or perhaps give small business owners more incentives to hire and expand, it will be those factors that most influence stock market returns.

As always, investors need to maintain a long-term outlook and let their goals and risk tolerance—and not short-term market movements like election year uncertainty—influence their allocation decisions. Nevertheless, the likely rise in volatility could create attractive opportunities to buy some stocks at a discount or take profits in others that have run their course.